Pacific Investment Management Co. and Morgan Stanley have started looking at creating the first unfunded emerging market managed synthetic collateralized debt obligations. At the moment emerging market CDOs are referenced to bonds and the arranger issues notes, according to structurers. However, with increasing liquidity in the default swap market firms are starting to look at synthetic transactions. Credit structurers predicted default-swaps could form a major part of emerging market CDOs, as they do in investment grade products, but said liquidity and fund manager expertise has to increase first.
Michael Nolan, executive director and European head of collateralized debt obligations at Morgan Stanley in London, said it is looking at structuring several emerging market CDOs, one of which could be unfunded. Any deal would likely be around USD200-300 million with 50/70 credits. However, Nolan predicted this would take six to 12 months. The demand for emerging market CDOs has increased in the last months, partly because investors want to diversify out of corporate credit, according to one credit structurer.
An official at PIMCO said emerging market bonds are still more liquid than default swaps, but said the asset manager would consider a 50/50 hybrid structure. The asset manager would make its investment decision according to relative value plays.
Ebo Coleman, v.p. and senior credit officer at Moody's Investors Service in London, said it has been approached by at least one firm looking at structuring these products, which he declined to name, about its rating criteria. Historically Moody's has required 20% credit subordination to get a single A rating on the mezzanine notes, compared to a level around 4-5%--depending on the structure--for investment grade corporate transactions. However, the rating agency is currently reviewing its criteria.
